Hearing on the Administration's "National Money Laundering Strategy for 2001"

Prepared Statement of Mr. Alvin James
Principal
Ernst and Young, LLP

10:00 a.m., Wednesday, September 26, 2001 - Dirksen 538

Thank you Mr. Chairman, Senator Gramm and Members of the Committee:

I am very pleased to be given this opportunity to speak to you today about money laundering. My name is Alvin James and currently I serve as the leader of the Anti-Money Laundering Solutions group at Ernst & Young, LLP. However, the views I am expressing here are my own and do not necessarily reflect the views of Ernst & Young. Less than two years ago, I retired from federal service after 27 years of law enforcement within the U.S. Treasury Department. Most of my public service was spent as a special agent with IRS Criminal Investigation Division where I specialized in international undercover money laundering investigations. I spent the last five years of my federal law enforcement service at the Financial Crimes Enforcement Network (FinCEN) concluding the last two years as their Senior Anti-Money Laundering Policy Advisor. As this Committee knows, one of the truly unique characteristics of FinCEN is its networking capability. It serves as a sort of hub for representatives from federal, state and local law enforcement agencies from across the United States. It was at FinCEN that a DEA colleague, Greg Passic, and I collaborated on developing a model that explained what is generally recognized as the largest money laundering system in the Western Hemisphere - the Colombia Black Market Peso Exchange (BMPE). That model, which was developed using law enforcement intelligence, describes how this underground financial system works and identifies vulnerable choke points. During my tenure at FinCEN I also served as the founding chairman of the Treasury Under Secretary for Enforcement’s BMPE working group.

Mr. Chairman, most of my testimony today will center on the BMPE as a global money laundering system. However, I would like to begin with a few remarks to highlight the use of the BMPE and other underground financial systems by international terrorists. Terrorists don’t usually need to launder money because terrorism, unlike other criminal activity such as narcotics trafficking, does not generate money. However, terrorists do need to move funds covertly. There are major similarities among all underground financial systems -also called parallel payment systems- including the BMPE, Hawala and the Chinese Underground Banking or Chit system. The most significant of these similarities is their ability to facilitate anonymous international transfers of money. This feature makes these systems attractive to terrorist groups. We know that they use these systems to covertly move the money they need to support their activities.

In light of recent events I would caution those who attempt to concentrate U.S. law enforcement resources on terrorist money laundering. A separate and distinct system of laundering or hiding money for terrorist activity does not exist. They use those systems of transferring and hiding funds that are most readily available, discreet and cheap. The longer we studied BMPE the more evident it became that this system of money laundering was used for not only a multitude of criminal activities but also legitimate commerce, capital flight, tax evasion and the simple transfer of assets. Recent developments also indicate that BMPE brokers have teamed up increasingly with partners in the Middle East. In addition to typical placement in the U.S., drug dollars are now being deposited in Lebanon, Israel and Palestine. Persons responsible for the first World Trade Center bombing also received funds from a BMPE broker working out of Venezuela. I feel that by fully identifying those individuals, businesses and banks handling BMPE transactions in the Middle East, we have an opportunity to flag transactions supporting all types of illegal activity including terrorism. Recent U.S. drug money investigations have revealed laundering through businesses in the Middle East. Some of those individuals are involved in terrorist circles. The knowledge that U.S. investigators gained by tracing funds generated by the BMPE cells operating in the United States will prove tremendously valuable in developing a workable game plan to pursue terrorist finances. The BMPE system is funded almost exclusively by drug money while the other systems that I mentioned are often funded by parallel transactions of legitimate trade. Thus for the BMPE, terrorism is yet another compelling reason to disrupt and ultimately dismantle this purely illegitimate system. In addition we must either bring the other systems under close scrutiny and regulation within the world’s legitimate financial community or dismantle them as well.

The remainder of my testimony will focus on the BMPE as a global money laundering system and the danger it poses to our country, as well as the challenges it presents to our law enforcement, business and financial communities. The BMPE presents numerous dangers to our country. Most directly this system facilitates the Colombian drug trade by allowing the Colombian drug wholesaler a relatively safe means to annually convert $5 billion generated by the sale of drugs in the U.S. to pesos in Colombia. In turn the BMPE makes these billions of dollars available as a commodity for sale outside our regulated financial system. There they are ready for those who need a discreet source of funds that is difficult to trace. As I mentioned earlier, U.S. law enforcement has evidence that some of these funds have been purchased in the past by middle-eastern terrorists including those who bombed the World Trade Center in 1993. The links to possible terrorist funding through the BMPE are even stronger today since, as we will, see the initial placement of drug dollars into U.S. financial institutions now begins in nations throughout the world.

The funds are also available to Colombian importers who wish to hide their purchases of U.S. trade goods that they smuggle into their country. This smuggling, totally funded by the BMPE, is so prevalent that the Colombian Government is unable to tax the sales of almost 50% of retail goods sold in Colombia. This lack of legitimate revenue destabilizes the Colombian government and hinders its ability to fight the narcotics suppliers on their home turf. In addition, Colombia’s business community has been destabilized because those businesses that choose to operate legitimately find it almost impossible to compete with those who sell smuggled goods. The Colombian drug traffickers are able to use their billions to fund the Colombian rebels who stand between cocaine and heroin production facilities and the governments of the U.S. and Colombia who are trying to eliminate the Colombian narcotics business. Finally, the rebels use this drug money not only to fund their military objectives but also to finance acts of terrorism aimed at promoting their cause and hindering their enemies in Colombia.

U.S. law enforcement has the authority, the ability and the knowledge to severely disrupt and ultimately dismantle the BMPE. By so doing it would force the drug traffickers and money launderers to use laundering tactics more vulnerable to law enforcement. There is considerable evidence that law enforcement can impact the BMPE system. Vigorous enforcement of the Bank Secrecy Act (BSA) and other anti-money laundering laws have caused the Colombian drug trafficker to be willing to sell his share of the drug proceeds to the BMPE peso broker for discounts in excess of 30% rather than take the risk of either moving the funds or laundering them himself in the U.S. The application of the Geographic Targeting Order to the money service businesses in New York City had a dramatic although short-lived impact on the ability of the BMPE system to place its drug currency and then move its funds. Undercover operations designed to infiltrate the BMPE system have been responsible for a shift away from currency placement in the U.S. to placement in foreign locations. However, in spite of these and the numerous other activities that have made up 20 years of law enforcement efforts in this area, I must also note that the BMPE still remains the primary vehicle used by Colombian traffickers to launder their drug proceeds. Money laundering systems are like a balloon. If you squeeze them in one place, they just get bigger somewhere else. The main challenge faced by U.S. law enforcement is to coordinate their activities in a systemic approach and pop the balloon.

It should be noted that many of our law enforcement efforts have been more notable for the degree to which they disrupted the system than for the law violators they brought to trial. However, the BMPE is a financial system and as such it is not dependant on any one individual or group of individuals. Therefore, a plan that is directed entirely toward arresting and prosecuting the drug traffickers and the money launderers who use this system will not by itself stop the system. The second major challenge for law enforcement is to place the goal of disruption and dismantlement of the system on an equal footing with prosecuting the individuals who use it. Of course Congress and the Administration are also challenged to measure their successes accordingly.

The U.S. financial institutions and their regulators face a different challenge. The financial community has done a pretty good job of implementing our anti-money laundering laws. Colombian drug traffickers have virtually stopped laundering their funds in the United States. They pay a substantial fee to the BMPE peso brokers to take this high-risk activity off their hands. The funds the brokers cannot handle, the traffickers smuggle out of the country, but sale to the BMPE is their preferred method. While the banks have not kept the drug money out of their institutions all together, they deserve some of the credit for the current shift of drug currency placement from the U.S. to foreign locations. However, therein also lies their challenge. A large portion of the drug currency that is being smuggled off shore is still being placed in the U.S. financial system through the international correspondent banking relationships between the respective foreign banks and their U.S. correspondent banks. While the front door of our U.S. financial institutions closes ever more tightly to those who would bring in ill-gotten gains, the back door of international correspondent banking gapes open. The challenge to U.S. financial institutions and their regulators is to close the unguarded back door.

Before I discuss these topics in more depth, let me first briefly describe the system.

The Colombian Black Market Peso Exchange is the most egregious example of an underground financial system used to launder dirty money. We believe that as much as $5 billion dollars in Colombian drug proceeds (or about half of U.S. wholesale drug proceeds) are laundered per year through this system. There are other underground financial systems or parallel banking systems that operate in much the same way throughout the world, such as the Hawala system in the Middle East or the Chinese Underground Banking or Chit system in Asia and the Pacific Rim. However, the BMPE system is the only one that is funded almost exclusively with illegal proceeds, namely drug dollars.

The sale of drugs in the U.S. generates currency. No one uses his or her checkbook or his or her credit card to buy drugs - at least not yet. Each tier of the drug sales and distribution organizations in the U.S. takes their cut of the cash and passes the remainder up the line. Finally the Colombian suppliers' wholesale share is amassed in secret stash houses in ports of drug entry such as New York City, Miami, Houston, Chicago and Los Angeles. At this point, the Colombian trafficker has a serious problem. Cash is not only heavier & bulkier than the narcotics he imported but also a more precious commodity. Drug manufacture and supply operations in Colombia operate at about 30 % of capacity. Therefore, if a shipment of drugs is seized, it is easily replaced, but if the money is lost it is irreplaceable. The Colombian drug trafficker’s dilemma is to get the value of that cash home to Colombia in pesos without detection by U.S. or Colombian authorities.

The BMPE peso brokers, always in need of a source of U.S. dollars, were a ready-made solution. The BMPE has existed since the late 1960s as a means for Colombian importers to pay for U.S. trade goods with dollars while avoiding tariffs enforced by the Colombian central banking system. The peso brokers provided the additional service of placing the dollars in the U.S. financial system and transferring them directly to the U.S. exporter on behalf of the Colombian importer. In the beginning peso brokers used Colombian exporters of goods to the U.S., such as cut flowers and coffee, as their source of dollars. However, the Colombian drug traffickers offered the peso broker a deal he could not refuse. The drug dollars were offered at a substantial discount, as much as 30%, to compensate the peso broker for the fact that the dollars he was buying were in the form of currency and carried considerable risk. The peso brokers began to alter the way they did business in order to place the drug currency in the U.S. financial system and to meet the needs of both sets of customers, the Colombian drug trafficker and the Colombian importer. Once the process was in place to handle the dirty money, there was little reason to go back to the old ways and pay full price for the dollars. The Colombian traffickers could provide a virtually unlimited supply of funds. If fact the annual wholesale Colombian drug proceeds are estimated to be between $8 and $12 billion. There is only enough demand for dollars through the BMPE to accommodate about half that amount. The end result is that the BMPE became almost wholly funded with drug dollars.

As stated earlier, the greatest challenge for law enforcement is the need for a coordinated approach. We have made strides in several areas of BMPE enforcement, but as yet we have not combined these successes in a coordinated attack on the BMPE system as a whole. I firmly believe that our only hope to destroy this system lies in the use of all our tools in a calculated effort to force drug dollars out of the relative safety of the BMPE and into an arena that offers less security to the drug trafficker and more susceptibility to law enforcement.

The substantially overlapping money laundering jurisdictions at the federal state and local levels is fundamentally responsible for the current lack of coordination in BMPE strategy. Most of our law enforcement agencies in this country have some form of money laundering jurisdiction. At first glance this looks like optimum coverage for money laundering enforcement. Let me also say at this point that there can be no doubt of the will of each and every one of these agencies to do their utmost to enforce money laundering laws. However, especially at the federal level, law enforcement administration is a competitive endeavor. There are only so many law enforcement dollars in the federal budget. Competition for those funds between the agencies is fierce. This problem is exacerbated by the federal asset forfeiture funds that return a proportional share of seized and forfeited funds back to the respective seizing law enforcement agencies. Asset forfeiture is a major part of most money laundering prosecutions. The ability to return seized assets to individual agency budgets only serves to fan the fires of competition in money laundering enforcement. Our efforts to include BMPE investigations in the National Money Laundering Strategy have not really addressed this problem.

These competitive pressures also work against cooperative investigations and sharing of information. True sharing of information and full coordination of investigations is vital if we hope to pop the money laundering balloon. We must get past the ugly questions of who gets credit for the prosecution or the seized assets. The BMPE operates on a truly global basis and its only limitation is safety and profitability for its users. It thrives in an environment where its adversary is hindered by a new set of rules each time a boundary is crossed, whether the boundary is between agencies, states or countries. We cannot afford to allow interagency competition to continue in this already complex enforcement environment.

The second challenge for law enforcement centers on our measure of success in this area. Our primary focus now is on the prosecution of individuals and the seizure and forfeiture of their assets. Of course this traditional approach remains an important leg of any enforcement initiative. However, the BMPE is not dependant on any individual or group of individuals to continue its operation. It operates on the demand for dollars available outside the traditional banking system. As long as those dollars are available and can be supplied safely to the users, the system will continue to operate. Further the system is large enough and the profits are substantial enough to entice replacements in spite of the risk of arrest and prosecution. Therefore, individual cases and prosecutions should not be our sole goal or the sole measure of our efforts in this area. Disruption of the system should be an equally acceptable goal of law enforcement action. Once again the challenge here is not only to pursue success along both lines of measurement, but to do so in a coordinated fashion so as to keep up the pressure on all fronts at one time.

Earlier I spoke about the Bank Secrecy Act (BSA) and its administration by bank regulators and how our financial institutions have had a profoundly negative impact on the ability of narcotics traffickers to move their illicit funds through our financial system. When Colombian narcotics began to arrive on the U.S. drug scene in mass the banks in the major entry ports, especially Miami, were literally awash in drug currency. At the outset drug traffickers were able to bring suitcases of currency into local banks and wire transfer it wherever they wanted. Law enforcement and bank regulators raised the alarm and the enforcement of the currency reporting provisions of the BSA came into effect. The effectiveness of that statute and the resolve of the banking community as well as the enforcement and regulatory arms of the government to keep dirty money out of their institutions has severely dampened the ability of money launderers to use our financial systems. Unfortunately, it has not been able to keep the dirty money out altogether.

Drug sales generate huge revenues and huge profits. The pressure generated by the need to move and launder these funds is immense. The BMPE is the primary vehicle used by the Colombian drug traffickers to counter the BSA. In fact the discount offered by Colombian drug wholesalers to the dollar peso brokers is one measure of the effectiveness of the BSA. The drug traffickers would rather sell their profits in U.S. currency at a discount of up to 30% than take the risk of laundering the dollars themselves. In so doing they pass the money laundering enforcement risk to the dollar peso broker. At first the peso broker was able to place the drug currency into the U.S. financial institutions by using transactions structured below the government’s and the bank’s detection thresholds. But the pressure that drove the trafficker to sell his funds at a substantial discount has mounted on the peso broker as well.

The broker has countered the pressure against currency placement in the U.S. through the use of international correspondent banking. The susceptibility of correspondent banking relationships to money laundering has been highlighted in a report compiled by the Permanent Subcommittee on Investigations. Senate Bill S.1371, sponsored by Senator Carl Levin, also addresses these weaknesses. The following is an example of money laundering through correspondent banking that relates directly to the BMPE.

The peso brokers have begun to smuggle large amounts of currency to nations whose banks have correspondent relationships with major U.S. banks. The nations of choice are those with either lax money laundering laws or lax enforcement of those laws. In return the foreign bank may sell a U.S. dollar check drawn on the foreign bank’s U.S. correspondent account. These dollar delineated bank checks carry the same weight as fully negotiable cashiers checks in Latin American markets. Therefore the checks are readily sold to the Colombian importer as dollar based financial instruments that are readily acceptable in these Latin markets. The brokers often go so far as to have the checks drafted with the name of the respective payee specified by the Colombian importer. The foreign bank may also accept the currency deposit and then order a wire transfer from their correspondent account to the account designated by the depositor.

The foreign bank is left with a large amount of U.S. currency and no bank wants to keep excess currency on hand. Since they do not have an account with the Federal Reserve, they get rid of the excess by sending a deposit of currency to their correspondent bank. This replaces the funds withdrawn by the check sold and eliminates the excess currency problem. The effect of this transaction is that we are back to suitcase deposits of U.S. drug currency into our financial system. The only difference is that the dollar peso broker uses the correspondent back door to the bank rather than the front door in Miami or New York.

The BSA has worked in that we have begun to force the dollar peso brokers to move their money off shore rather than structure the deposits here in the U.S. The challenge presented to banking community and their regulators is to keep up the pressure in the U.S. while also keeping drug currency placement out of their correspondent institutions as well. Law enforcement sources have noted an increase in correspondent BMPE activity in Haiti, Guatemala, the Dominican Republic, Venezuela, Israel, Lebanon, Palestine and Australia. When one views this list it is easy to see that these dollars can be made available to individuals with much more heinous purposes in mind than smuggling duty free refrigerators into Colombia. The BMPE is a global problemcalling for global coordination. Given the recent terrorist acts, it is even more imperative that we force these billions of dollars out of this system that can make them so easily available on a truly global basis to anyone with a need for covert funds.

In conclusion I would like to restate that our government has the ability, the authority and the knowledge to take action now against the BMPE. The question is how do we bring our forces to bear in such a way that the BMPE will be dismantled? I believe the answer lies in eliminating the problems brought on by fragmented anti-money laundering jurisdiction. I suggest that this can be accomplished by the creation of a special task force at the highest possible level, which would have the charge to coordinate and direct our law enforcement efforts against the BMPE and other underground financial systems. The most important first step for this task force is to create a single repository for law enforcement money laundering intelligence. This repository must include a method to retrieve even the most sensitive law enforcement information on a real time basis. If we ever hope to truly dismantle these systems we must put this most valuable recourse in the hands of a task force that is responsible for the big picture. In addition, once they have this information, they must have the authority to disseminate it, as they deem appropriate for their mission. The task force should also have the power to take action on their own or direct the efforts of other law enforcement operations working along these lines. Law enforcement has seen the need for this type of combined effort, but to date they have been unable to achieve the desired level of cooperation. I believe a high level task force will achieve the sought after results.